Tax Expenditures and the Budget Deficit

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“Tax expenditures” are an opaque form of government spending that operates through the tax code – instead of the government making direct payments to individuals or institutions, tax credits are issued. In total, they cost the U.S. government about $1.1 trillion annually – roughly equivalent to the country’s enormous budget deficit.

Deficit reduction plans, including Paul Ryan’s Path to Prosperity andSimpson-Bowles, have proposed eliminating tax expenditures as a means of making the tax code simpler and less distortionary. Cutting tax expenditures, however, is politically challenging – in some cases perhaps impossible. Take, for example, the imputed rental income from which homeowners benefit – that is, the estimated income they would get if they rented out their homes, while living in rental accommodations themselves. Subsidyscope estimates that not taxing this income cost the government $27 billion in FY 2009. But taxing imputed rental income would be brutally hard to sell as an elimination of a distortionary tax break.

Who benefits from tax expenditures? This varies widely by item. As seen in the figure above, of the seven precisely measurable tax expenditures worth over $20 billion, three accrue disproportionately to households earning over $200,000 a year. The largest such is the mortgage interest tax deduction, costing the government over $80 billion a year. It is less a means of encouraging home ownership than a means of encouraging the well-off to borrow more than they need to buy bigger homes than they need. American legislators should summon the courage to follow the British example and phase it out.

I thought mortgage deductions were capped, but maybe I am wrong. Perhaps if this were phased out and the “rich” still felt they “needed” a larger house they would be encouraged to move out of New York, Boston and San Francisco to smaller more remote cities. You could then have a redistribution of both weath and the wealthy.

Posted by Joe BellAugust 16, 2012 at 11:41 am

Omits the very important subsidy of employer sponsored health plans.. .

The U.S. Department of Treasury estimates the tax expenditures for the employer health benefit exclusion and other employer-related health benefits to be $132.6 billion in 2006, making the exclusion the single largest tax expenditure in the federal budget.[3] The exclusion is 66 percent larger than the deduction for home mortgage interest ($79.9 billion), which is a distant second, followed by capital gains on home sales ($43.9 billion), the child tax credit ($42.1 billion), and contributions to personal retirement savings.

Posted by rrrahu1August 16, 2012 at 12:03 pm

Mortgage deductions should remain in place, but only for primary residences.

Posted by Bruce BartlettAugust 16, 2012 at 4:10 pm

The mortgage interest deduction is capped at $1 million of mortgage debt.

Posted by KhioriAugust 18, 2012 at 12:40 pm

First, Britain may not have it but they still have economic woes. It is not a cure-all. Second, are you implying that more people should simply be happy to live in smaller, probably rental, shelter? How delightfully Russian! The largest group benefiting is obviously people making $100-200K. My guess is that’s mainly 2 people working, each for LESS than $100K. And I’ll bet the majority are closer to the $100 than the $200 pole. How exactly will these people benefit from giving more of their income to the government? Will it be doled out to the military? Or to banks that need “help”?

Only 4.3% of income tax filers had incomes above $200,000 in 2012 according to the Joint Committee on Taxation. This small and wealthy percentage receives about 75% of the mortgage interest deduction, about $70 billion a year, according to this chart. See this source for Congressional JCT, page 28: http://www.novoco.com/hottopics/resource_files/jcx-18-12.pdf
The top 5% own 75% of all financial assets and take in 30 to 35% of all personal income. They are the last people who need a tax give away.
The effective overall tax rate on incomes over $200,000 is about 30% according to Citizens for Tax Justice: http://ctj.org/ctjreports/2012/04/who_pays_taxes_in_america.php

Posted by grenz nutzenAugust 22, 2012 at 10:54 pm

why not flip the axes so that one could read the words?

also, on the rhetorical flourish policymakers employ here: “tax expenditures.” imagine the schoolyard bully coming around every recess demanding 75 cents of your lunch allowance for the privilege of not having your head sat upon. then, one day, he insists that his daily collections aren’t enough to cover costs (he’s doing more bullying at other playgrounds around town and travel/accoutrements have gotten more expensive), so he’s going to have to end your “rug burn credit” and “un-wedgie deduction.” dare i say the entire discussion presumes the bully is entitled to whatever money he wants for whatever undisciplined (and worse) spending he enjoys?

Posted by PacerAugust 31, 2012 at 1:02 pm

The mortgage interest deduction makes as much sense as a deduction for credit card finance charges (nothing more than a sop to lenders, who no doubt gross up their take to offset the tax benefit). Interest is still a cost, and debt should not be encouraged. If there is a desire to encourage homeownership through the tax code, just have a flat deduction for one’s primary residence–indexed to inflation. However I am not sold on the myriad personal and community benefits that are attributed to home ownership in the first place. If anything it’s a false proxy for creditworthiness and income (two things that in most times are prerequisite to buying a home – but are often also applicable to renting in the case of all but the most casual landlords).

Adding back imputed rental income is just silly. Makes as much sense as taxing imputed taxi earnings on a person’s automobile. We don’t charge income on what a person COULD earn, given their skills and wherewithal. We tax what they actually earn.

Posted by mattAugust 31, 2012 at 1:57 pm

I don’t know the facts on this one. However, my guess is that the people that are getting the largest deductions for mortgage interest also have the largest mortgages.

Is the takeaway for this article that we should discourage home ownership?

Posted by JohnSeptember 4, 2012 at 8:16 am

The rich do often move out of those cities to buy larger houses. If they own a business within the city, they declare the house out of the city as their “primary residence” & then use the residence in the city as a complete write off & save millions in taxes.

Posted by Mike CiaraldiOctober 4, 2016 at 6:43 pm

Ben Leet — I think you are mis-reading the chart if you say that those with income over $200K receive 75% of the mortgage income deduction. To me it looks like they get $30 billion (the slice from $55 B to $85 B). Those making $100K to $200K get $35 billion (the slice from $20 B to $55 B). And the rest of us (including me) get the final $20 B.
So the percentages are 35%, 42%, and 23%.

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